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Is Slovenia en route to a banking sector bail-out?

With speculation rife that Slovenia could become the next eurozone country in need of financial rescue, Christine Lagarde, the managing director of the International Monetary Fund, put out a statement on Saturday (20 April) saying: “I would not trust the rumours.”

But the eurozone has been here before. The rumours soon develop into fevered speculation, which – after official denials – transform ‘if’ into ‘when’, particularly once the financial markets smell blood. Soon the possibility turns into inevitability. Is there anything to suggest that Slovenia will be any different?

Worries about the small former Yugoslav republic’s economy have been bubbling threateningly for months. In the past few weeks, as a new government was installed in Ljubljana, they have surged to prominence. The situation was important enough to be discussed – albeit not in great depth – by eurozone finance ministers at their meeting in Dublin a fortnight ago.

The country’s new finance minister, Uroš CC?ufer – formerly a director at NLB, Slovenia’s largest bank – gave a presentation to his eurozone counterparts, as is the custom when new ministers join the Eurogroup, and assured them that his government would sort out the country’s problems without the need for external assistance. “I am calm,” he said after the meeting.

Yet problems for the new government of the eurozone’s fourth smallest economy are mounting. The messy Cyprus solution showed what happens when warnings about the need for reform go unheeded. Just as in Cyprus, Slovenia’s problems stem from a fragile banking sector. Alenka Bratušek, the country’s prime minister, said that recapitalisation was her centre-left government’s “number one priority”. Ministers are planning to sell state assets and use revenues estimated at about €1 billion to plough into the country’s three biggest banks. A ‘bad bank’ is set to be created to take the banks’ bad assets off their books.

Slovenia’s problems could become insurmountable if that €1bn is found to be insufficient. In a report published earlier this month, the Organisation for Economic Co-operation and Development (OECD) warned this could indeed be the case. Some analysts insist the requirement could even run to two or three times that amount. The OECD placed the blame firmly with the banks, saying that they had indulged in “excessive risk-taking”, were badly run and had been subject to “insufficiently effective supervision”.

Deeper problems

This would be bad enough, but the government is wrestling with deeper economic problems. The budget deficit is widening, from 4.4% last year to an estimated 5.1% this year. When Slovenia shook off its communist shackles, it omitted to privatise its banks and much of its industry. Allegations of political interference are never far away. It has also failed to attract foreign investment in the way that other former Eastern bloc countries have done, relying on exports instead. In the good times this did not matter, and Slovenia was held up as a poster child for post-communist development. But when the global financial crisis hit, Slovenia’s problems were laid bare just as export demand fell away.

Now, the country has been hit by a double-dip recession, exacerbated by the bursting of a large property bubble. This is where the banks become culpable. They granted too many loans to people and companies who struggled to pay them back. At current official estimates, €7bn of these ‘bad loans’ are dragging the sector down.

So it is hardly surprising that the OECD talks about “additional and far-reaching reforms… needed as soon as possible” and that the European Commission, in its winter economic forecasts published on 22 February, says that for a (still sluggish) recovery to be even sighted next year there needed to be a “swift resolution of the banking crisis”.

“Slovenia is facing a very demanding task,” said José Manuel Barroso, the president of the European Commission, after meeting Bratušek on 11 April, adding that the country needed “tailor-made measures to put the economy on a sustainable path”. Whether Slovenia manages to avoid a bail-out will largely depend on whether the government has the support and stomach to force through its agenda.

There are factors in its favour that distinguish it from Cyprus. Its financial sector relative to GDP is much smaller. Its public debt, at an estimated 53.7% of GDP in 2012, is one of the smallest in the eurozone and far below the ratio seen in other eurozone countries to receive a bail-out.

Yet the “rumours” remain and will linger for some time. Eurozone politicians have seen these self-fulfilling prophecies before. They know they may already have singled out the next eurozone victim.